Proper inventory management is crucial to running a successful business – and there are many different variables that are involved in ensuring your company always has an appropriate level of inventory on hand at all times. One of the most important variables is inventory forecasting, which helps in knowing your company’s reorder point, or the point in time when inventory needs to be restocked so you don’t risk overstocking or understocking.
The consequences of not knowing the reorder point could be quite detrimental to your business and its perception in the marketplace.
What is a Reorder Point (ROP)?
A reorder point, or ROP, describes a period when inventory needs to be restocked so your company doesn’t run the risk of running out of supply. It’s a key component of managing inventory. If your business runs out of inventory and can’t supply its products to customers, it’s going to result in delays and a more negative brand experience. That’s why it’s so important to implement reorder points accordingly to trigger new orders. Effective inventory forecasting plays an important role in determining accurate reorder points.
Just as a reorder point is important for keeping items in stock, it’s also an important metric for preventing overstocking. Overstocking on supply can lead to higher expenses and also run the risk of obsolescence or changing consumer preferences before you’re able to sell through it. Hence, the reorder point, guided by precise inventory forecasting, is important for helping companies maintain the right level of inventory at all times.
What is the Reorder Point Formula?
Reorder points can be calculated using a simple formula and knowing a few key metrics. To determine ROP, you’ll need to know the demand during lead time and the safety stock. The formula is as follows:
- Reorder point = Demand during lead time + safety stock
So how do you calculate the demand during lead time and safety stock metrics to help determine reorder point? To determine the demand during lead time, you’ll need to figure out your company’s average daily sales first. Average daily sales are your total sales divided by a number of set days. This number of days could be one week, one month, etc. Next, you’ll need to determine your lead time. The lead time is the number of days between when you place an order with a manufacturer and when your company receives that order. Demand during lead time is determined by multiplying the lead time, usually in days, by the average daily sales number you just determined.
Finally, you’ll need to determine your safety stock levels, or the extra inventory you keep on hand in anticipation of any ebbs and flows in supply or demand. Think of safety stock as insurance inventory – it’s the supply you keep in the event of a “just in case” sort of situation. Here is the safety stock calculation formula:
- Safety stock = (Maximum daily order x maximum lead time) – (Average daily orders x average lead time)
Once you have these two important metrics – demand during lead time and safety stock – you can revisit the reorder point formula to determine when you’ll need to replenish inventory.
Say your company sells hockey helmets and your demand during lead time is 150 and your safety stock is 65. By using the reorder point formula, you know that when your inventory reaches 215 hockey helmets, it’s time to replenish your inventory.
Understanding the Significance of Reorder Points
ROP is a crucial aspect of inventory management, especially when it comes to preventing going out of stock and also preventing overstocking. It’s designed to strike that perfect balance where you always have inventory to sell to customers, but never too much inventory where it becomes a cost burden on your business.
Managing reorder points effectively and efficiently can go a long way toward appeasing your customers and also reducing overhead costs. In terms of reducing overhead, you don’t want your company to have more inventory in stock than what can be sold in a timely manner. It’s a poor use of capital and other resources. At the same time, it can be a cost burden for your company to restock inventory every time you completely run out. Getting expedited goods from a supplier or manufacturer can be costly. So too can any loss of business from customers shopping elsewhere if they can’t get what they want from you.
What Calculating Reorder Points is Crucial
Learning how to calculate reorder point correctly has many benefits for a business when it comes to managing inventory. It can save money, save time and increase business opportunities.
Knowing the reorder point and following it as part of your company’s inventory management can help strike that perfect balance between having too much inventory and too little inventory. Too much inventory, and you’re spending money on storing and warehousing it. There’s also the chance that customer preferences shift and your product becomes obsolete before you have a chance to sell it all. This can cause a business to absorb many of the costs of acquiring that supply. Too little inventory and you’re likely not able to get products out to customers in a timely fashion. This can hurt your company’s reputation and result in lost business as customers shop elsewhere for products.
Calculating reorder points also takes into account purchasing trends over a set period of time. It can help assess any consumer demands or preferences to help you forecast demand more accurately. This demand might be seasonal or based on any current trends. For instance, with the hockey helmet example, companies are likely to see an uptick in demand in the fall and winter seasons when hockey is primarily played. The spring and summer, conversely, are likely to be the times of the year when there’s less demand for hockey helmets and other hockey equipment.
How to Calculate Reorder Points
The reorder point formula is determined by adding the demand during lead time and the safety stock, but it’s not as easy of a metric to determine as it might initially seem. To determine it, you’ll need accurate lead times, safety stock numbers and average daily sales numbers. You’ll also likely need to regularly adjust and adapt these numbers over time to continue to ensure you have accurate reorder points that work for your business and properly balance inventory. Here’s a closer look at each of the variables that go into determining ROP:
Lead Time
In order to calculate demand during lead time, you first need to know what your lead time is. As a reminder, lead time is the amount of time – usually measured in days – between when you place an order with a supplier or manufacturer and when that order arrives. Various factors can affect lead time. For instance, if you work with suppliers or manufacturers overseas, your firm might save money, but your lead time is likely to be greater than if you worked with a domestic supplier or manufacturer.
Once you know your lead time, you can multiply it by your average daily sales to determine lead time demand.
Safety Stock
Think of safety stock as “insurance inventory.” That is, it’s the inventory that you always have on hand in case inventory dips too low and you have to meet any changes in demand. It’s always a good idea to have safety stock on hand, as business can be unpredictable at times and it can be difficult to fully anticipate any variability. There may also be times when restocking inventory can be more difficult due to issues with raw materials or problems throughout the supply chain. The safety stock level is a bit more complicated to determine. Here’s how to do it:
- Step 1: Multiply the maximum number of daily orders that your company processes by the maximum lead time that might be required. Hang onto that metric.
- Step 2: Multiply the average number of daily orders by the average lead time. Hang onto that metric.
- Now, take the end metric from Step 2 and subtract it from the metric you determined in Step 1.
Here is the formula:
- Safety stock = (Maximum daily order x maximum lead time) – (Average daily orders x average lead time)
Average Daily Sales
Average daily sales, or average daily usage, is simply the amount of product that you’re selling on a daily basis. It’s calculated by dividing your total sales by a specified number of days to see how much product you’ve sold during this amount of time. Usually the number of days, or period of time you’re analyzing, is a week or a month. Once you have the average daily sales number, you can multiply it by your lead time metric to determine lead time demand. This can then be plugged into the ROP formula and added to the safety stock to determine reorder point.
Effective Strategies for Setting Reorder Points
Reorder points typically aren’t metrics that stay consistent for too long. It’s important to adjust and adapt over time as your business grows and changes to ensure you’re able to continue to stock adequate inventory and meet any changes in demand. This is especially true when you consider that there are some limitations to note about reorder points. For example, it tends to be a more rigid and less flexible methodology which can present difficulties for more complex operations. Additionally, it can be difficult to determine if there’s fluctuating demand.
Here’s a look at some strategies to help ensure the accuracy of reorder points:
- Invest in good inventory management software: A good inventory management software solution helps provide companies with advanced insight to make better data-driven decisions.
- Dynamic reorder point adjustment takes into account the variability of supply and demand using historical data and other real-time information to create more accurate ROPs over time.
- ROP calculations should be regularly reviewed and updated. This is especially true as a business evolves and changes over time. You’ve heard the saying “what got you here won’t get you there.” It’s true for more than just business strategy, but for ensuring reorder points are kept up to date as well. It’s best practice to review the ROP at least once a year, but this may need to be more regular depending on how fast your business is growing.
Case Studies and Examples
Whether you’re a small business or a national brand, you’re going to use a reorder point. How you use it and how often you have to adjust it may differ, however. For example, a business that doesn’t see a lot of demand or seasonal fluctuations is going to have a lot more consistent reorder point than a larger brand with a more complex logistics system.
Common Mistakes to Avoid in Reorder Point Calculations
Reorder points aren’t a perfect solution, and there are some common mistakes that companies make that can make them even more of an imperfect solution. Here’s an overview of some of the common pain points you’ll want to avoid when it comes to determining the reorder point:
- Make sure you fully understand your lead time. It’s an important metric used to determine the reorder point. Oftentimes, it’s either underestimated or overestimated.
- Don’t ignore demand variability. This is the change in the quantity of products or services that are purchased over time.
- Don’t base inventory decisions solely on historical data. Make sure you anticipate expected future demand as well.
- Don’t adjust and adapt when it comes to determining the ROP. As businesses change, so too do the various metrics that are needed to determine the reorder point.
It’s important to follow the various effective strategies that are used to optimize the ROP in your company. Investing in good inventory management software is one strategy that can help with ROP calculations. Another important strategy is regularly reviewing and updating ROP calculations based on changing data.
FAQs on Reorder Point Formulas
Here’s an overview of some of the more frequently asked questions we receive about reorder points:
What factors should I consider when setting safety stock for reorder point calculations?
There are several factors that should be used to determine what is a good safety stock level. Factors such as inventory flexibility, projected future demand and supplier lead times should all play a determining role. Sales volume is another important factor to consider as it pertains to setting safety stock for reorder point calculations.
How often should I reevaluate and adjust my reorder point?
How often you evaluate and adjust reorder point largely depends on your business and how fast factors like demand change. At a minimum, companies should aim to revisit their reorder points on an annual basis. But depending on how quickly your business changes and how much demand increases, it may need to be updated on a more regular basis. Bottom line: Don’t wait any more than a year before reevaluating ROP, but plan on revisiting it more frequently than that.
Can I use reorder point calculations for seasonal or fluctuating demand products?
Yes, you can use reorder point calculations for seasonal or fluctuating demand. However, you need to be sure to adjust the average daily demand and the lead time in the formula to get an accurate picture of what the ROP is during peak times and when there’s fluctuating demand. Failure to adjust those key variables won’t give you an accurate ROP when demand increases.
How do I incorporate lead time variability into my reorder point calculation?
Lead time variability is uncertainty in the time it takes to complete the overall supply chain process. Think of it from the time an order is placed to the point where that product is delivered. If it’s not managed correctly, lead time vulnerability can lead to inventory shortages, excessive stock and higher costs. It can also have an impact on your customer service. Incorporate lead time vulnerability into your ROP calculation by doing demand forecasting, maximizing the efficiency of inventory management, streamlining production processes to the best of your ability and making continuous improvement a priority in your operations.
What is the difference between reorder point and reorder quantity?
Reorder point is an indication of when it’s time to restock inventory. Reorder quantity is the size of the inventory that needs to be restocked. Just as there’s a formula to determine the reorder point, there are various factors to determine reorder quantity. These factors include delivery time, total cost and the cost to maintain the minimum level of stock.
Elevate Your Inventory Management with ShipCalm
ShipCalm is here to help you and your business better manage inventory and reorder points more effectively and efficiently thanks to our advanced knowledge, expertise and wealth of company solutions in inventory management and supply chain management. Contact us today to learn more information on our personalized solutions and expert guidance and to set up a consultation so we can help you take your business to the next level.
